Question

Kahn Inc. has a target capital structure of 60% common equity and 40% debt to fund its $10 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 16%, a before-tax cost of debt of 11%, and a tax rate of 40%. The company's retained earnings are adequate to provide the common equity portion of its capital budget. Its expected dividend next year (D₁) is $4, and the current stock price is $33.

1. What is the company's expected growth rate? Do not round intermediate calculations. Round your answer to two decimal places.
     %
2. 
   
3. If the firm's net income is expected to be $1.8 billion, what portion of its net income is the firm expected to pay out as dividends? (Hint: Refer to Equation below.)
   
   Growth rate = (1 - Payout ratio)ROE
   
   Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Answer a)

WACC = (Cost of Equity * Weight of Equity) + (Cost of Debt after tax * Weight of Debt)

16% = Cost of Equity * 0.60 + 11% * (1-0.40) * 0.40

16% = Cost of Equity * 0.60 + 2.64%

Cost of Equity = (16% - 2.64%) / 0.60

Cost of Equity = 22.27%

Value of Stock =

33 =

33*0.2227 - 33* G = 4

7.3491 - 33* G = 4

G = (7.3491 - 4) / 33

G = 10.15%

Answer b)

ROE = Net Income / Shareholders' Fund

= 1.80 / 60% * 10 billion

= 0.3 OR 30%

Grwoth Rate = (1-Payout Ratio) * ROE

10.15% = (1- Payout Ratio) * 30%

1- Payout Ratio = 10.15% / 30%

1- Payout Ratio = 0.33833333333

Payout Ratio = 1- 0.33833333333

Payout Ratio = 66.16%

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